Signs of hope emerge for value investors

New concerns about the limits to growth in Big Tech have planted a seed of doubt in one of the most enduring, profitable trades of the past decade.

Led by the biggest names in the U.S. tech sector, growth stocks have driven the market upward for most of the post-financial-crisis era, leaving value investors persistently underperforming.

But after Facebook Inc.’s big miss last week, the market saw a brief but sizable rush out of growth and into value – potentially the early signs of a long-awaited comeback of value investing, and of a reckoning for the mighty tech sector.

Story continues below advertisement

“It feels like there are cracks that are starting to spread,” said Lori Calvasina, head of U.S. equity strategy at RBC Dominion Securities. “This is a phenomenal sector on a great run, and the fundamentals are great, but I see parts of the investment community starting to get wary.”

In reporting quarterly earnings, both Facebook and Netflix Inc. raised doubts about user growth, sending a jolt through the FAANG group of stocks, which also includes Apple Inc., Amazon Inc., and Google parent Alphabet Inc.

The eventual levelling out of growth is both natural, as the limits to market penetration start to come into view, and poisonous to an investment theory based on breakneck expansion.

“As a technology matures, growth peaks out,” Martin Roberge, a portfolio strategist at Canaccord Genuity, said in a recent note. “The decline of Netflix and Facebook could signal a cycle peak in the Nasdaq index and the growth-to-value investment theme.”

Traditional value investing, which focuses on rooting out cheaply valued stocks, has long been stuck in the shadow of growth strategies fuelled by companies with profits expanding quicker than the market average.

And while any sector of the stock market can have companies that appeal to growth investors, the tech sector in general, and the FAANGs specifically, have come to dominate the growth trade.

Up until mid-July, the FAANG stocks had produced average growth rates ranging from 23 per cent to 64 per cent, each year for the past five years, elevating the broader tech sector to a size unseen since the early 2000s.

Story continues below advertisement

Story continues below advertisement

As of May, the total market capitalization of companies listed on the Nasdaq rose to more than half the total for New York Stock Exchange listings “for the first time since, well, before the tech wreck,” Sal Guatieri, senior economist at BMO Nesbitt Burns, said in a note. He added the caveat, however, that today’s tech champions typically “make good money,” unlike many of the companies that fuelled the dot-com bubble.

Morgan Stanley, meanwhile, recently sold one-quarter of its large-cap growth position, the firm’s chief U.S. equity strategist Michael Wilson said in a note. “Our call was that these groups are likely to get hit next and, indeed, we think a meaningful correction in these asset categories began late last month."

As Facebook and Netflix shares were each hit with declines of at least 20 per cent, investors swiftly shifted money out of growth and into value in what amounted to the largest such three-day rotation since the aftermath of the Lehman Brothers bankruptcy in 2008, according to a Nomura strategist.

Of course, Apple Inc.’s quarterly results put an end to the slide, as stronger-than-expected performance and guidance propelled the company on Thursday to the world’s first US$1-trillion valuation. In the two trading days since Apple reported, the Nasdaq Composite Index has rebounded by 2.3 per cent, raising the possibility that the tech run is back on after a brief interruption.

While that may be so, both tech and growth strategies remain extremely crowded, Ms. Calvasina said.

Story continues below advertisement

“This not something that’s going to be resolved in a couple of days with a couple of stocks going down 20 per cent,” she said. “This is a big problem and it’s going to take time to work its way out of the system.”

Tickers mentioned in this story

Data UpdateUnchecking box will stop auto data updates

Comments

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff. Non-subscribers can read and sort comments but will not be able to engage with them in any way. Click here to subscribe.

Welcome to The Globe and Mail’s comment community. This is a space where subscribers can engage with each other and Globe staff.

We aim to create a safe and valuable space for discussion and debate. That means:

All comments will be reviewed by one or more moderators before being posted to the site. This should only take a few moments.

Treat others as you wish to be treated

Criticize ideas, not people

Stay on topic

Avoid the use of toxic and offensive language

Flag bad behaviour

Comments that violate our community guidelines will be removed. Commenters who repeatedly violate community guidelines may be suspended, causing them to temporarily lose their ability to engage with comments.

Due to technical reasons, we have temporarily removed commenting from our articles. We hope to have this fixed soon. Thank you for your patience. If you are looking to give feedback on our new site, please send it along to feedback@globeandmail.com. If you want to write a letter to the editor, please forward to letters@globeandmail.com.